The net profits of a partnership business, after providing for income tax for the last five years were: Rs.80,000; Rs.1,00,000; Rs.1,20,000; Rs.1,25,000; and Rs.2,00,000. The capital employed in the business is Rs.10,00,000, and the normal rate of return is 10%. The value of goodwill on the basis of the annuity method, taking the present value of the annuity of Re. 1 for 5 years at 10% as 3.7907 (approx), will be:

Correct option is C

To determine the value of goodwill using the annuity method, we follow these steps:

Step 1: Calculate the Average Profit

Given the net profits after tax for the last five years:

Year 1 → Rs. 80,000

Year 2 → Rs. 1,00,000

Year 3 → Rs. 1,20,000

Year 4 → Rs. 1,25,000

Year 5 → Rs. 2,00,000

The average profit is calculated as:​

Step 2: Calculate Normal Profit

The capital employed in the business = Rs. 10,00,000
The normal rate of return (NRR) = 10%

Step 3: Calculate Super Profit

Super Profit = Average Profit - Normal Profit

Super Profit = 1,25,000 - 1,00,000

= 25,000

Step 4: Calculate Goodwill Using the Annuity Method

Formula for goodwill using annuity method:

Goodwill = Super Profit × Present Value of Annuity Factor

Given:

• Super Profit = 25,000
• Present Value of Annuity for 5 years at 10% = 3.7907

Goodwill = 25,000 × 3.7907

Goodwill = 94,767.5 or 94,770 (approx)

Information Booster:

Annuity Method in Goodwill Valuation

• This method is used when a firm expects excess profits for a certain period and considers the time value of money.
• The present value of an annuity factor helps in determining the present worth of future super profits over a specified period.

Why Super Profit is Considered?

• Super Profit = Excess earnings above normal profits (i.e., goodwill reflects extra profits the firm generates due to reputation, efficiency, or customer loyalty).
• In this case, the firm is making Rs. 25,000 above the normal profit annually, so goodwill is calculated based on this value.